Denmark’s largest pension fund is optimistic about its ability to refine and improve its quantitative stock picking model by adding human capital as a new predictor of company performance, after promising backtesting results.
As part of the DKK 936 billion (€ 126 billion) fund’s growing focus on how holding companies deal with their human capital – which encompasses not only workers’ rights, but also working environments. work and staff involvement – ATP finds it realistic that the data on this issue can be used to find the alpha.
In its recently released Human Capital Report 2020, ATP said that after examining the likely consequences of expanding the selection model of its foreign equity portfolio, which has a market value of around $ 49 billion. Danish crowns, to integrate human capital, the results had been encouraging. .
“If we had to draw a cautious conclusion from our survey, it is that the results are broadly in line with financial research on human capital. Companies that are successful in maximizing their human capital by attracting, retaining and developing their staff appear to fare a little better financially than companies that mismanage their human capital, ”the pension fund wrote in the report.
In other words, he said, ATP might be able to slightly increase its expected return by overweighting companies with good human capital management.
Ole Buhl, ESG manager of the statutory pension fund, told IPE: “While focusing on our investments, we believe we have found academic evidence that good human capital management has worked and that value creation is there. anchored.
“There are academic papers that show this is one way to find alpha,” Buhl said.
In its report, the Danish pension fund cited a study by US professor of the labor market Mark Huselid showing that companies that prioritize good recruitment and performance management systems, as well as involvement and through additional training of personnel, thereby achieving higher productivity and growth.
British finance professor Alex Edmans has also shown that companies with highly satisfied staff generate higher returns for shareholders, according to the report.
Using an MSCI human capital data point, ATP performed an approximately five-year backtest of its own historical data to see what the portfolio and performance impact would have been had it chosen actions to a greater extent depending on their ability to manage human capital.
“The timing was not enough, but the direction was the right one – we are very optimistic now,” said Buhl.
“The timing was not enough, but the direction was right – we are very optimistic now”
Ole Buhl, ESG manager of ATP
So now ATP is looking for the right high-quality data spanning a longer period of time than the original study to bring it to the point where it can add human capital as another factor in its quantitative algorithm for foreign stocks, alongside the four he currently uses. – low risk, momentum, value and climate.
While ATP’s domestic equity portfolio is managed very differently from the foreign allocation – using a bottom-up fundamental approach – it is this side of the trade that will serve as the source for some of the data needed to achieve a human capital factor for the quantitative algorithm.
“We have a long tradition of active ownership in Denmark, and we use it to connect with and learn from companies.
“Four companies known for this work have opened their doors to us,” he said, declining to name the companies.
Buhl said he was very happy with ATP’s latest work on human capital as it represented a shift towards a proactive approach compared to the active, but reactive, nature of how he dealt with the issue during over the past 20 years.
“Just as we are not going to wait until the ocean has risen a few meters before acting on the climate, we want to push companies in the right direction when it comes to managing their human resources, and not just reacting to the horrible cases brought to our attention, ”he said.
Even though human capital has long been a key component of corporate profitability, Buhl said the investment community seemed to have forgotten to take it into account.
“If we live in an increasingly knowledge-dependent society, and that knowledge is in people’s heads, then human capital becomes even more important,” he said.
“What has kept investors from falling into the ‘S’ of ESG is that ‘the’ measure has been missing,” he said, adding that while there are many measures of human capital that could be used, there was no aggregate measure available.
“It may also be that there has not been a global tradition for companies to report on this, and that is why we are also intensifying our work on different standards for SASB. [Sustainability Accounting Standards Board], who are starting to establish reporting requirements in this area, ”said Buhl.
From 2020 to 2021, ATP participates in a working group as part of the SASB’s human capital management project, which aims to develop a framework to ensure better integration of human capital topics into consulting standards.
Because it is still early days for such initiatives, Buhl said investors need to find their own metrics to some extent, adding that ATP’s recent plan to map its entire equity universe to identify the companies that did not meet his human capital needs helped him develop these tools.
“The best people to talk to in this job are the companies themselves – the ones who have thought about how to make the most of their human capital,” he said.
ATP now had much more capacity to conduct its own ESG research, Buhl said, with his department having moved over the past five years from a one-person operation to one with 10 employees and “very active” support. ‘elsewhere in the pension fund.
ATP announced last month that it had added a new formula to the stock-picking algorithm for foreign stocks that predicted which utility companies would reduce their greenhouse gas emissions the most.
IPE 2020 Conference and Awards
The presentation “Don’t choose between sustainability and performance” as part of the session “Asset Allocation Perspectives: Focus on ESG” on the second day of the conference demonstrated how human capital has been a key issue. key source of sustainable business growth.
To view the presentation and any other session of the conference, please register here.